Is Tesco's dream of building an international empire unravelling?

When Sir Terry Leahy took Tesco into the US in 2007, he was driven by the
knowledge that the company had seemingly achieved success in international
markets as diverse as Poland, Ireland, South Korea and Thailand.

Tesco chief executive Philip Clarke said the company is making progress on improving its performancePhoto: Reuters

After Tesco became the biggest food retailer in the UK in 1995, Sir Terry and his management team had set their sights on international domination.

The company became a market leader in parts of Asia of Eastern Europe, which prompted Tesco to believe it could prosper in the US with its new Fresh & Easy venture.

However, six years on from Tesco’s entry into the US, the health of the company’s international businesses looks rather different.

Under Philip Clarke, who replaced Sir Terry in 2010, Tesco has quit Japan and the US, the latter at a cost of more than £1bn, and, perhaps more worryingly for investors, has now revealed every single one of Tesco’s remaining international businesses has fallen into sales decline.

In the 26 weeks to August 24, all nine of Tesco’s overseas markets recorded a fall in like-for-like sales. This included a 12.8pc drop in Turkey, a 6.9pc fall in the Czech Republic, a 4.7pc decline in Thailand, and a 3.7pc fall in South Korea. This meant that trading profits in Asia fell 12.4pc and profits in Europe slumped 68pc.

The slide in Tesco’s overseas profits, which is far larger than analysts expected, is a warning about the health of the global economy, emerging markets in Asia and the prospects for the eurozone.

To a certain extent, Clarke and Tesco have also been unlucky. The retailer’s business in South Korea, which is its biggest outside the UK, has been effected by government restricting Sunday trading hours for large companies, while retailers in Hungary have had to deal with a 2.5pc crisis tax on their revenue.

However, there are now questions about whether Tesco chose the right strategy in its overseas markets. For example, does it have too many out-of-town hypermarkets in Europe? And, how does it plan to compete with the growth of discount chains?

In Poland, Clarke says Tesco has suffered from the rise of “proximity retail”, with consumers choosing to shop in convenience stores rather than the company’s hypermarkets.

“People are shopping closer to home and avoiding driving out to big stores to save fuel,” Mr Clarke said.

In response, Tesco is launching a turnaround plan in Poland, where it has 450 stores and more than £2bn of annual revenue, which is similar to its £1bn “Build a Better Tesco” strategy in the UK. Its is improving the presentation of fresh food, cutting prices to compete with discounters, and even rolling out a bistro dining concept within its stores to try to differentiate from the competition.

Meanwhile, in Thailand the company believes it made mistakes with its promotional strategy and is revamping its “Clubpack” range of bulk-buy products that is used by small traders.

However, in Turkey, a more radical solution may be required for 30 loss-making Tesco shops opened in the east of the country.

Clarke has shown that he is prepared to draw the line under failed overseas ventures by pulling out of Japan and the US, and giving up control of its Chinese stores.

The joint venture with China Resources Enterprise’s Vanguard business, which was confirmed alongside the interim results, looks a neat solution to Tesco’s Chinese problem. The company has gone from owning 100pc of 134 stores with little prospect of making a profit, to 20pc of a venture that has more than 3,000 stores and is the biggest food retailer in China.

Lang Chen, the chairman of CRE, said the partnership is a “compelling combination of global expertise and local knowledge”.

However, much like the exit from Fresh & Easy, this is a costly deal for Tesco. It will pump in around £185m to the joint venture and also pay out £160m to CRE over the next two years.

Since arriving in China in 2004, Tesco has spent £1.6bn on developing the business. Yet, the latest interim results show the company still lost £110m in China in the last six months alone, worse than the £104m lost from the disastrous Fresh & Easy.

Investors will be hoping that Tesco’s remaining overseas operations such as Poland, Thailand and Turkey do not go the same way.

Clarke insisted that Tesco has no plans to pull out of further markets. Referring to the Asian operations specifically, he said: “We think these businesses will do well for a long time.” Laurie McIlwee, the finance director, who led the US and China deals, added that Tesco will “fight our way through a difficult macro environment”.

Nonetheless, the slump in profits outside the UK has given Clarke another fire to put out.

The Tesco boss focused on the UK last year and has reassured investors that the domestic business, which still accounts for more than 70pc of profits, is getting back on track.

But, while Tesco has been fixing its castle, its empire has fallen into mutiny.